China's thus far futile tactics to control an overheating economy are straight out of an economics textbook. As any economics student worth his or her salt will tell you, the primary tools for conducting monetary policy include (1) setting target interest rates, (2) determining reserve requirements, (3) engaging in open market operations, and (4) using moral suasion. China has hiked its benchmark rate and increased its reserve requirement so many times I've lost count. Also, it's been busy issuing sterilization bills to ensure that its massive foreign exchange intervention does not result in excess domestic liquidity. So, they've tried (1) through (3) repeatedly without much desired effect. What's left? The old standby (4) "moral suasion" is a fancy term that, in plain English, involves monetary authorities telling financial institutions to do as they say--or else. When all else fails, threaten the @#$%^& implicitly with some form of implicit punishment for not playing along. It's what China has now resorted to as it tells everyone to stop lending so much. From Forbes:China has reached for its customary tools to curb a surge in domestic liquidity, issuing directives restricting bank lending to business customers and consumers.
In the stealth administrative style preferred by China’s policymakers, the China Banking Regulatory Commission has since late September quietly instructed domestic banks not to hand out loans to industries now widely known as the “Two Highs, One Surplus.” The “two highs” are industries consuming high levels of energy or producing high pollution, while the ”one surplus” generally refers to industries suffering from excess capacity, top among them being real estate developers.
Domestic banks were given the orders at a meeting in late September; the instructions were passed on to foreign banks when they were summoned to a meeting last Thursday.
News of the lending curbs first surfaced in early October in local newspapers, when they started to track down incidents of qualified consumers unable to receive loans for housing mortgages, a line of lending that is among the safest and most lucrative for Chinese banks.
An evening newspaper in the northeastern city of Shenyang reported a suspension of housing loans to comply with regulators’ decrees as early as in mid-October, citing officials at several branches of Chinese commercial banks. The paper also said that lending to real estate was being affected by an earlier policy directive, issued in June by CBRC, which instructed banks to cap their yearly lending growth rate to the sector at 15%.
Lending has also been reportedly curtailed in Shenzhen and Guangzhou for small loans for new business owners as well as other consumer finance needs such as home repairs, particularly those made by a dozen midsized banks, including China Minsheng Bank, the Bank of Communications, China Everbright Bank, China Merchants Bank and Shenzhen Development Bank.
In late October, national business newspapers such as Securities Times confirmed an extension of the lending curb to the corporate sector, a tightening that would particularly affect loan growth at small and medium commercial lenders and corporate clients that are not deemed as “bright prospects.” It said the country’s big national banks were also starting to feel the pinch.
The latest development came in a report last week in China Business News, which quoted informed sources as confirming regulators’ concerns about the fast expansion by foreign banks into real estate lending as well as allowing money flowing into stock markets potentially to create a bubble.
Foreign banks have been more aggressive than their domestic rivals in extending domestic loans denominated in yuan, with their loan-to-deposit ratio at more than 1.5 as of the end of September for those banks based in Shanghai, up from just a 23.4% ratio early in the year, China Business News added.
Coercive policy like this, however, can only go so far. The lending curb could help temporarily prevent Chinese banks from rapidly building up their loan books and might put a damper on their profitability, but analysts were expecting pent-up demand to be unleashed at the beginning of the new year.
CBRC denied it is imposing a blanket freeze on lending, as it did with its previous lending freeze, back in April 2004.
The construction sector tends to be hit the hardest by policy-engineered credit controls, and commodity and property demand will likely be the areas first to be affected by credit tightening, according to Goldman Sachs economist Hong Liang. She said Beijing is facing a dilemma in resorting to traditional tightening tools such as interest rate hikes; this option "has become much more painful for the China’s central bank," mainly because the drying up of the speculative yuan carry trading may lead to more hot money inflows, a trend already under way since the Fed cut rates in September.
Hong also pointed to the pressure arising from the surge in China’s trade surplus, which grew by 27 times between 2003 and 2007. "If the growth rate of these [net foreign] assets continues to run at the pace we have seen in the past few years, the ‘ceiling’ on domestic credit growth would need to be lowered each year in order to keep the broad money supply growth stable," she wrote in a note issued on Monday.
